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Cash Rents VS Crop-Share and Sec 199A deduction and SE Tax

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If farmer/landlord (who does not materially participate in the farm operation) has cash rent arrangement with tenant, it would appear that the activity does not rise to the level of a trade or business for purposes of Sec 199A deduction and the income would be reported on Sch E and not be subject to SE tax. Correct?

 

If the arrangement is crop-share where the landlord does materially participate it would appear that the activity does rise to the level of a trade or business for purposes of Sec 199A deduction and the income would be reported on Sch F subject to SE tax. Correct?

 

Is there an arrangement whereby the landlord could get the Sec 199A deduction but not have the income subject to SE tax? In other words, the activity and arrangement would qualify as a trade or business for purposes of 199A, but not rise to the level of material participation for purposes of SE tax?

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This exact topic came up in the all day seminar sponsored by the OSCPA that I attended on Tuesday where we spent al least 3 hours on 199 A.

The coauthor and presenter was Chris Hesse, a National Tax Partner for Clifton Allen Larson. He is the past chair of the AICPA Ag Conference, author and presenter of the

Farm Tax Update and Chairman elect of the AICPA Tax Executive Committee. I recite all this background because these are his answers, so if you want to argue or

disagree your fight is with him not me.  Mr. Hesse's answer was, the farmer landlord needs to have some involvement that at least rises above the farm equivalent of a

Triple-Net Lease. In his opinion, there is absolutely no requirement for the income to be subject to SE Tax. He at least needs to be paying the property taxes

and have some additional involvement, perhaps buying fertilizer, maintenance of buildings, erosion control etc. You may find more answers at their website

claconnect.com since their headquarters is in Minnesota and they specialize in Ag Tax issues.

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1 hour ago, artp said:

If farmer/landlord (who does not materially participate in the farm operation) has cash rent arrangement with tenant, it would appear that the activity does not rise to the level of a trade or business for purposes of Sec 199A deduction and the income would be reported on Sch E and not be subject to SE tax. Correct?

 

If the arrangement is crop-share where the landlord does materially participate it would appear that the activity does rise to the level of a trade or business for purposes of Sec 199A deduction and the income would be reported on Sch F subject to SE tax. Correct?

 

Is there an arrangement whereby the landlord could get the Sec 199A deduction but not have the income subject to SE tax? In other words, the activity and arrangement would qualify as a trade or business for purposes of 199A, but not rise to the level of material participation for purposes of SE tax?

Landlord receiving a crop share reports on form 4835, not subject to SE tax.  But the courts have determined that receiving a crop share in itself does not raise the activity to the level of a trade or business. Such would be the case of the landlord whose involvement is limited to depositing a check for his share of the crops.

 

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Thanks for the reply. 
My client pays the real estate taxes, maintains out buildings for storage of equipment and pays property and liability insurance and consults with tenant regarding land usage-so ongoing profit motive. Payment arrangement is combination of flat cash amount per acre with potential bonus based on crop yield and other contingencies. Considering taking 199A and treating income as non SE.

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Here is a post by on a blog called "The Farm CPA" that sheds more light on the issue:

The Farm CPA

By: Paul Neiffer

 

Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.

Rentals - Is it QBI or Not?

Nov 14, 2018

I would say that most of the emails and calls that I am getting right now on Section 199A is whether rents will be Qualified Business Income (QBI) or not.  This blog post will provide my QBI conclusion on various types of rentals that farmers and farm landlords will typically have.  However, I would like to start out with some of the case history directly related to farming and rents and see why this is so hard to know for sure based on the current proposed regulations.

First, let's review the history of CRP rents.  CRP contracts call for payments from the government in return for the landlord taking the ground out of production typically for 10 years.  In return, the landlord will usually plant native grasses and other plants and "maintain" the property for the term of the contract.  The maintenance in most cases is minimal.  For several years, the IRS viewed these payments as not being trade or business payments subject to self-employment (SE) tax.  However, starting about 15 years ago, the IRS started to assert these payments were related to a trade or business and subject to SE tax.  Finally, in the Morehouse case, the Tax Court ruled that CRP landlords were in the trade or business of being an environmental friendly farm business and thus, subject to SE tax.  Finally, this case was overturned by the Circuit Court and ruled that the CRP is in fact rents and not a trade or business.  The IRS still views these payments as being trade or business income (even though they lost in court).

Second, we have a long case history starting with the Mizell case dealing with whether rents received from related parties are in fact trade or business income subject to SE tax or are in fact rents not subject to SE tax.  In one of the latest cases, the Martin ruling indicated that as long as the rents are at FMV and call for no involvement by the landlord, then the rents are not subject to SE tax.  It is the active involvement by the landlord that causes "rents" to rise to the level of a trade or business, not simply any sharing of income or expenses.

The bottom line of all of this case history is that landlords have to have some level of involvement in the "farm activities" to rise to a trade or business.  Simply collecting cash or even a share of crops without any involvement likely does not rise to the level of a trade or business.  And finally, even if we have that involvement, it is likely that the IRS will assert that the landlord at that point owes SE tax on the rents and will likely fully offset any tax advantage of the 199A deduction for lower income taxpayers.

Here is my current verdicts on whether rents are QBI:

  • Rents received by landlords that are part of a common group - QBI
  •  
  • Rents received by landlords who may be related parties, but do not meet the requirement to be a common group.  For example, Son is the farmer and Sister is the landlord.  We don't know if Son and Sister are related parties even if mom and dad are alive and even if they are alive, are they required to have ownership in the farm operation and the land entity. - May Be QBI
  •  
  • Cash rents received by landlords individually who may be owners in the farm operation, but do not meet the common group definition and have no involvement in farm operations as landlords (i.e. no SE tax on rents) - Not QBI
  •  
  • Same as previous example, but landlord has active involvement in decisions, etc. and is paying SE tax on the rents - QBI
  •  
  • Cash rents received by landlords renting ground to unrelated third parties and have no involvement - Not QBI
  •  
  • Cash rents received by landlords renting ground to unrelated third parties, having involvement and likely paying SE tax - QBI
  •  
  • Crop share landlords simply receiving a share of crop and only paying real estate taxes, crop insurance and interest and no involvement - Not QBI
  •  
  • Crop share landlords paying share of chemicals, fertilizer and have some involvement, but not rising to the level of SE tax - Likely QBI

All of these current conclusions are based on the current propose regulations.  The final regulations will likely provide additional clarity on all of these types of rents and there may be material changes to all or some of these conclusions.  We will keep you posted.

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